Finding value in equities in most markets is never easy at the late stages of a cycle and certainly not when new technologies are disrupting various important industries. But for value managers, an environment of disruption is about more than picking winners and avoiding losers. It’s also about picking survivors and adaptors.
Caroline Cai, a principal and portfolio manager at Pzena Investment Management in New York, said on a trip to Australia last week that it was difficult to know what changes were structural and what were temporary. Even in an industry which is seeing massive disruption, such as retail, there are businesses which will be able to adapt to the new world and prosper once more.
“If you can find a franchise which is defendable then there’s a lot of upside potential,” she said. “But any transition costs money.” As an example, Pzena bought Wal Mart about the time when it announced it was reinvesting in its stores and expanding its online business. With Wal Mart, the company had been expanding its grocery section for some time, while maintaining a “one-stop shop” image. Groceries, particularly fresh produce, are not as easily sold online as, say, books. A retail outlet is a more efficient distribution point than a warehouse. Pzena bought into Sainsbury and Tesco for the same reasons.
Pzena believes that, while the US and some other markets are overvalued at the moment, there are still opportunities for value managers in the sectors under disruption stress. “If you add up all the aspirations of businesses in a market segment they will usually come to 120 per cent,” Cai said. “It makes sense, too, because you don’t want to do something unless you think you can win.”
She said there were similarities in the current environment with that of the tech boom of the late 1990s. Valuations were not as extreme now, as in the late 90s, and a lot of people were taking comfort from big-name mega-cap stocks which had long-term growth potential and also good profit margins.
“But what is similar is the belief that what is working now will keep on working. Whoever is winning today will win down the road, for sure. It’s the certainty aspect. But it’s hard to see all of them being winners.”
Another difference is that companies are staying private longer than in the tech boom and the owners’ exit strategies seem to be more centred on M&A activity rather than IPOs. “A lot of fintech start-ups don’t really want to become financial services companies,” she said. “They want to be bought.”
Financials represent Pzena’s biggest overweight position in its global portfolio, with holdings including US ‘money centre’ banks, ING and HSBC. The manager believes smaller banks and some emerging markets banks are vulnerable, however.
Greg Bright is publisher of Investor Strategy News (Australia)
